Markets cheer Bank of Japan’s move

Japanese exporters welcomed the weaker currency, which makes their products much more competitive on global markets, but there is a risk that their profits could also be squeezed.
Photo: Tomohiro Ohsumi

That’s the question that investors are asking after the bank’s new chief Haruhiko Kuroda unveiled what he called “an entirely new dimension of monetary easing, both in terms of quantity and quality’’.

The Bank of Japan is now aiming to double the size of the country’s monetary base over the next two years by aggressively buying long-term bonds in an attempt to rid Japan of the deflation that has plagued the country for the past 15 years.

“I am confident that all the policies we need to achieve 2 per cent inflation in around two years are now in place," Kuroda said.

Markets cheered the Bank of Japan’s move, which will see it spending will trillions of yen buying long-term Japanese bonds, and billions of yen in financial instruments linked to stock and property markets. The Nikkei 225 stock average rose by 2.2 per cent, while benchmark 10-year bond yield fell to a record low of 0.425 per cent. The yen tumbled from ¥92.90 to the US dollar to a two-week low of ¥96.12.

But economists pointed out that the bank faces a difficult balancing act as it tries to kindle inflation, while keeping a cap on bond yields.

So far the Japanese bond market – which is almost two and a half times the size of the country’s economy – has been stable. Bank of Japan is counting on the fact that its massive purchases of Japanese bonds will keep yields steady. But there is a risk that if inflation starts to rise, or the central bank wants to slow its purchases, turmoil could erupt in the bond market, with bond prices tumbling and yields rising sharply. Any significant rise in Japanese bond yields would be a clear signal that the bank’s strategy is failing.

What’s more, economists point out that the Bank of Japan’s bond buying is aimed at artificially depressing yields, particularly on long-term bonds, in order to encourage investors to shift their money into riskier assets, such as shares and real estate. This should boost asset prices, and encourage investment.

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But there is a risk that prices start rising ahead of wages, particularly if a lower yen causes a sharp rise in the price of imported goods. This would crimp the purchasing power of Japanese consumers who would be forced to cut back on spending, which would ultimately dent economic activity.

And although Japanese exporters have welcomed the weaker currency, which makes their products much more competitive on global markets, there is a risk that their profits could also be squeezed if a sharp fall in the currency pushes up the cost of imports such as oil.

Finally, there is a risk that monetary stimulus – even on the historic scale that the Bank of Japan is now contemplating – will fail to produce major changes in the attitudes and behaviour of Japanese consumers, businesses and investors and that the country will remain mired in its deflationary trap.